Welcome!

This paper studies how firms communicate information to investors through an intermediary that maps a firm’s disclosures into discrete categories (e.g., credit ratings, ESG grades, audit opinions, and financial statement items). I show that this discrete structure can discipline strategic misreporting. When the intermediary provides sufficient scrutiny and employs an appropriate number of ratings, intermediated classifications can prevent inflation, improve informational efficiency, and reduce aggregate signaling costs. Furthermore, optimally designed classification standards typically generate category distributions that are less skewed than the underlying fundamentals, unless the classification is quantile-based.

We develop a model where firms choose whether to comply with an accounting rule that places an upper bound, such as historical cost, on the report and mandates recognition of bad news. Firms may also make unregulated assertions that their value exceeds the upper bound permitted by the accounting rule. In this context, improved enforcement of accounting rules enhances the credibility of firms’ unregulated claims. Firms’ willingness to recognize large impairments depends mostly on misreporting costs, while their willingness to recognize small impairments depends mostly on investors’ prior beliefs and whether a small impairment would be interpreted favorably. Consistent with our model, we find preliminary empirical evidence that investors respond favorably to small impairments by firms with low market values relative to book value.

Firms adjust operating capacity via substantial acquisitions, expansions, divestitures, and spin-offs, and exert significant search effort identifying opportunities to do so cost effectively. We embed capacity adjustment and search in a dynamic model to understand how they interact with the firm’s operating decisions (risk-management), financing decisions (distributions and capital raises), and liquidity (cash position). We find that capacity-related search efforts are U-shaped in firm liquidity: highest when firms have either small or large cash positions. The firm’s costly efforts to mitigate operational risk move with capacityrelated search (acting as strategic complements) when liquidity is low and diverge (acting as substitutes) when liquidity is high. We provide testable predictions related to the frequency of major capacity adjustments, net capacity growth, payout timing, cash-flow volatility, and capital raises. We also relate our predictions to firm life cycle classifications based on firms’ cash flows.